Buyer Beware: Reverse Convertible Notes

The Securities and Exchange Commission has commenced an investigation of reverse convertible notes.  Reverse convertible notes are a financial product that pays interest but is also tied to the performance of an underlying stock.  The notes pay a fixed interest rate and guarantees a return of the investor’s initial investment after a specified period of time unless the underlying stock price falls below a certain trigger price.  If the trigger price is reached, then there may not be a guaranteed return of principal.

While the reverse convertible note may pay an attractive rate of interest, the principal invested is subject to significant market risks of the underlying stock.  Reverse convertible notes are not just another type of bond.

The SEC investigation is examining whether Wall Street brokerage firms:

  • Failed to adequately disclose the risks and fees to investors;
  • Failed to disclose potential conflicts of interest; and
  • Improperly marketed and sold these notes to investors.

 An example of the problems with reverse convertible notes is demonstrated by a note based on the performance of the stock price of TiVo, the recording device maker.  The total return on the TiVo notes was less than $600 per $1,000 invested, i.e. a negative total return of -40%.

While reverse convertible notes may be an appropriate investment for investors looking for higher income, they are complex, expensive products that are subject to the risks associated with owning equities. 

Investing in investments, like reverse convertible notes, has risks that should be explained to the investor.  Just because an account or an individual investment has decreased in value does not necessarily mean that a financial adviser has acted inappropriately.  At Crary Buchanan, we provide consultations concerning negligence arising from improper financial advice.  We invite you to call us to discuss your rights and remedies under the law.

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